Conifex Timber Inc. (CFF) Earnings Call Transcript

Good afternoon, ladies and gentlemen. Welcome to the Conifex Timber Inc. Q2 2021 Results Conference Call. I would now like to turn the meeting over to Mr. Ken Shields. Please go ahead.

Well, thank you, Patrick, and good afternoon, everyone, and welcome to this call covering our first half 2021 results. I'm joined today by Chief Financial Officer, Winny Tang; and Operating Head, Andrew McLellan. After a few brief opening comments, I will hand the call over to Andrew to review operations, and Winny to review our finances. I then plan to review some important near-term developments that we believe will strengthen competitiveness and future cash flow generation at our Mackenzie complex. We will then respond to any questions that shareholders and analysts may have. But first, let's quickly deal with the housekeeping items. We will be making forward-looking statements and references to non-IFRS measures and, therefore, call your attention to the warning statements set out on Pages 1 and 2 of the MD&A that we released earlier today. For the second quarter, our net earnings were $26.1 million, equivalent to $0.56 per share. EBITDA was $37.8 million. This brought our first half results, net earnings, up to $30.6 million or $0.66 a share and first half EBITDA up to $47.5 million. The sequential improvement in quarterly earnings was driven by dramatically higher lumber prices, improved lumber shipments as railcar supply normalized and $2.8 million in business interruption insurance proceeds. The settlement we reached with our power generation plant insurer verifies the statements Andrew and I made on previous calls to the effect that neither employee errors nor gaps in maintenance procedures triggered the curtailment at the power plant. I'll now turn the meeting over to Andrew, who will update you on our lumber and power businesses.

Thank you, Ken, and good afternoon, everyone. First, I wish to reemphasize that our #1 priority is to protect the health and safety of our employees, their families and community members. Towards the end of Q2 and so far in Q3, successfully achieving this objective became more of a challenge due to heat wave in our home province. The resultant wildfires led to harvest curtailments created some shipment cancellations at our sawmill in Q2. We also incurred extra cost trucking lumbers to service our customer base when railcar supply was sporadic. We owe a debt of gratitude to our employees who helped us maintain a safe workplace amid COVID pandemic and helped mitigate disruptions in log and railcar suppliers. We also thank our contractors who made their equipment employees [indiscernible] and efforts. On my last 2 calls, I noted that the combination of heavy snow pack and wet weather last spring extended the spring breakup period and led to log harvesting and delivery shortfalls at mainly the northern interior region of British Columbia. Consequently, our sawmill operated at 83% of capacity in the first half of 2021. Now that our log inventories are being replenished through our active summer logging programs, we plan to extend the operating hours at our Mackenzie mill later this month. Our MD&A disposals that we are targeting an operating rate of 90% in Q3 and an even higher rate in Q4. As always, any number of unanticipated pandemic or wildfire-related production or shipment disruptions could hold back and prevent us from achieving these production targets. Our power business performed well in the quarter and continues to meet its production targets going forward. I will now turn the discussion over to CFO, Winny Tang. Thank you very much.

Thank you, Andrew, and good afternoon, everybody. We ended Q2 with cash of $35.8 million and available liquidity of $45.8 million. The $10 million revolving credit facility we arranged late last year remains undrawn. Gross debt at the end of the quarter totaled approximately $62 million, of which $59 million is limited recourse debt related to our over $100 million investment in green power production. We also have obligations totaling $2.7 million from leased office spaces and mobile equipment. After deducting cash, we ended the second quarter with net debt of $20.1 million and a net debt-to-capitalization ratio of approximately 12%. Our Lumber business is in an enviable financial position with nominal debt and significant cash balances. We deposited $7.8 million in duties in the first half of 2021, and we now have USD 16.3 million on deposits as potentially refundable. Our capital expenditures totaled just under $3 million in the first half of 2021, and we expect to expend a similar amount in the second half of the year. We also expect to pay minimal cash taxes this year and also into the next year as well. In December 2020, we commenced our normal course issuer bid, entitling us to repurchase and cancel up to 2.94 million shares. In the second quarter, we repurchased or canceled 1.45 million shares. Since inception, we have repurchased and canceled 2.38 million shares at a total cost of $5.5 million. Our average purchase price of $2.31 per share represents a 28% discount to our June period book value of $3.21 per share. Subsequent to the quarter end, we amended our credit agreement to allow us to repurchase and cancel up to $9 million of our shares between October 1, 2021 and September 30, 2022. For reasons that Ken will discuss, we believe our share trades well below our estimate of fundamental value and we believe the share buyback was an optimal use of excess cash. I will now turn the meeting back to Ken.

Well, thanks, Andrew and Winny. Since delivered log costs account for about 3/4 of the cash cost of producing lumber in the interior region of BC, the competitiveness ranking of any sawmill complex is driven by the procurement costs and the quality of the available sawlog supply. We think it makes sense to use the remaining time today to bring you up to date on our fiber supply situation. We summarize key information about the Mackenzie Timber Supply Area in Slide 7 and 8 in the deck we distributed. The Chief Forester has indicated that she expects to release an updated harvest level determination. And these are commonly referred to as allowable annual cut or AAC determinations, but she plans to release a new determination for the Mackenzie TSA before the end of 2021. Under the new AAC determinations, we believe we will have ample access to better quality sawlog. Here's why. First, let's discuss trends in log volumes. As indicated in Slide 7, the Chief Forester presently requires operators at Mackenzie to source the majority of their sawlog requirements from dead and damaged pine stands. Last year, the Ministry disclosed that 60% of the dead pine and the timber inventory in the Mackenzie TSA have lost commercial value and was no longer suitable for lumber production. With this disclosure, it is evident that the shelf life of the remaining beetle damaged stands in the Mackenzie TSA has expired. This explains why we expect to be able to access a higher-quality greener log diet in 2022 and beyond. A greener log diet provides us opportunities to materially improve lumber recovery. Here, of course, we have fewer defects in the logs, and more of each log is available as finished lumber. It also allows us to reduce unit cash conversion costs because we have fewer production jam-ups in our saw lines and our planing and finishing lines. And probably most important of all, it allows us to boost our lumber grade outturns, which leads to much higher average lumber selling price realizations. In this ladder area, with a green log diet, we believe we can move about 10% of the output of the mill from low-grade lumber, which sells for something like a discount of $100 per thousand board feet below construction-grade lumber prices. We think we can move about 10% into a premium grade which sales at about $100 premium. So you can see that the effect of a greener log diet is for something like USD 20 or say CAD 20 after duty. And with 200 million-plus of annual lumber capacity, that's a swing in cash flow generation of over $4 million a year. So this is why we're excited about this. And we believe that with redetermination of the harvest level of mix that we will migrate to a lower position on the global softwood lumber industry concentrate. Let me talk a couple of minutes about log availability. Based on our review of the future AAC within the interior region of BC in general and in Mackenzie in particular, we believe that the Mackenzie TSA will likely contribute at least 6% of the total harvest in the interior region of BC. Since Canfor closed its Mackenzie mill in 2019, we operate the one remaining sawmill complex in the Mackenzie TSA. At capacity, I know we'll consume about 2% of the interior BC AAC. If the Canfor mill restarts at capacity, it could consume about 2.5% of the interior BC AAC. So given that the Mackenzie TSA is expected to account for about 6% of the total fiber in the interior of BC that consume only 4.5% of the fiber, it's apparent that surplus sawlogs are available to us in Mackenzie. And this explains the notes that we put at the bottom of slide 6 -- on Slide 6, which makes the statement that we have one of the highest degrees of timber sawlog efficiency of any sawmill operator in British Columbia. So in anticipation of having chemical supplies to better quality sawlogs, we've got 3 comprehensive studies that are underway. The first study examines the scope and scale of the potential modernization and expansion of our Mackenzie sawmill's rating. We believe we have a solid opportunity to boost lumber production capacity by about 25%, reduce cash conversion cost and further improve lumber recovery grade outturns and sales realizations. Our objective, to identify a plan that enables us to sustain positive cash flows and lumber prices that at a cyclical low and a plan that produces attractive returns on investment even under conservative lumber price assumptions. The second study we have underway focuses on the diameter-class quality characteristics and moisture content of the sawlog supply we expect to access over the next decade and possibly longer. This crucial information will help us specify the machine center and dry count attributes and performance requirements for any modernization project. A third study that we have underway focuses on the potential to build and operate a log merchandising facility at our Mackenzie site to process our internal requirements but also to optimize the potential proceeds from the sale of surplus sawlogs chartered to the Mackenzie and sold to fiber deficit sawmillers of Prince George. We expect to finalize these 3 studies shortly after the new AAC determination is announced. We also expect that any project we may approve in the future will be phased in over time and funded through a combination of our cash balances, potential export duty rebates or refunds and drawdowns under our existing credit facility. While we await the release of updated harvest level and mix determination, we intend to continue to repurchase and cancel shares. We have equity in a power plant that we value at over $1 per Conifex share, cash on our balance sheet worth over $0.80 per share and duty refunds worth as much as $0.45 per share. This totaled $2.25 per share. Our recent trading price was $0.50 per share lower than the total of these 3 items. Clearly, stock market investors presently accord a negative value to our tenures and sawmill complex assets that we believe are valuable and that we are proud to own. Therefore, we continue to believe that our stock is undervalued by a huge amount, given the robustness and quality of the timber inventory in the Mackenzie TSA and given the high-return capital investment opportunities available to us. That sums up the key points we wanted to make. We very much look forward to our next call with you, and we would be pleased to respond to any questions shareholders and analysts may have, so we'll turn the meeting back to Patrick.

[Operator Instructions] We will take the first question. Please go ahead.

Paul Quinn, RBC. Sure. Okay, I'll ask you a question. Now that you've got your balance sheet in good shape again, just what are you looking to do? Is it less -- are you looking to get back at M&A? Or is it more upgrades on the sawmill?

Paul, good question. Today, all of our study and analysis has been focused on internal enhancement projects, optimizing our existing timber and sawmill and power plant space. We have not been looking for external acquisition opportunities. The rationale is importantly driven by the fact that we remain with internal projects, we can control the scope and scale and speed of the funding that's required. And so that's why we're continuing to look internally.

Okay. And then maybe we've got a pretty hot summer going here. Just wondering what the update on fire situation is in Mackenzie, whether you expect any shuts to occur in Q3 here?

Paul, it's Andrew McLellan here. We've been fairly fortunate with the conditions in Mackenzie and somewhat different than we've seen in the southern interior in BC. So we're not anticipating that we'll have anything out of the ordinary here in the back half of August into September. We did have some disruptions in Q2, but it was limited to about 2 weeks of shortfalls in all the deliveries. We entirely shut down all deliveries, but we had a 2-week period that were impacted by fires.

Okay. And then Ken, you mentioned that log cost BC interior, about 75% of cash costs. You obviously got hit with a huge runoff in stumpage on July 1 and poised to see another price increase on October. Are you guys able to make cash at these levels of stumpage, especially given the quality of the fiber you're bringing in?

Well, let me mention a couple of things about that, Paul. And they're both very good questions. First of all, we found that the heavy snowpack and difficult weather conditions that we had in Q1 forced us to incur extra log costs buying wood to make up for some shortfalls that we experienced and spending extra money by pushing up growth, so we could all work when ground conditions were very wet. So as a consequence of that, our non-stumpage-related sawlog costs in the second half of this year will be lower than they were in the first half and stumpage will be a bit higher. So all the reviews and scrubbing of numbers we've done indicate that we are going to have a modest single-digit increase in delivered log costs in the second half of the year compared to the first half. Coming back to the question -- your second question is that, I think, Paul, that if you looked at our operating earnings in the first 6 months of this year and divided them by 93.3 million board feet of shipments, you'd find that we had something like $450 of operating income per 1,000 board feet, and there's probably $25 or so of depreciation in that. But in any event, the operating income is right around $450. And through to last Friday, our average selling price realization was about CAD 450 lower than it was in the first half of this year. So right, today, we are at approximate breakeven. And in the quarter to date, we would be slightly ahead of our cash costs. But now we're about to experience the sub-$500 benchmark price orders that we'll be shipping, so we probably dipped into negative cash flow territory right now. But if there -- at this moment, we're continuing to, as Andrew said earlier, we've got a robust summer logging program that enables us to get our fixed costs over a larger number of units. And we are also looking at adding our sawmill complex, and we think that will enable us to reduce our cash conversion cost a bit. So right at this moment, there's not an overwhelmingly powerful argument to take downtime because it's not clear to us yet that the procurement cost would be materially different than our operating one. But who knows what will happen? Our own view is that the correction of lumber prices has large requirement [ and cost ] and now that -- we've got some seasonal improvement opportunities in shipment coming up, and as you and others have written about, there's certainly some restocking in certain lumber market segments. So we think lumber prices are more likely to go up from here and that there is an urgent need to consider downtime at this moment.

Okay, fulsome answer. Maybe just lastly, just -- I'm quite confused at your hedging strategy. It seems like I see quarters where lumber prices are going up, and you've had losses. And the lumber prices are going down and you have losses. So maybe you can just remind us what your hedging strategy is and when it's going to start to work for you again.

[Technical Difficulty] I'm sorry, the moderator line disconnected.

Okay. Well, good afternoon, once again, everyone. It's Ken Shields. We've had an unusual development with the phone system here, and we got dropped from the call. So presumably, you're still on the line. And I was in the midst of answering Paul Quinn's question about our hedging strategy. And it is -- the background to our hedging strategy is that we did obtain some price protection, and then we experienced this incredible run-up in lumber prices, and we took significant losses in Q2 or -- pardon me, in Q1. We took further losses in April of Q2. And towards late May, early June in Q2, we unwound our positions, and we did not -- we ended up covering our position at much higher than the $500, $600 level that they reached at the end of the quarter. And so there was a bit of a loss in Q2 in addition to Q1. We have no positions on the books now, and we don't anticipate doing anything materially in the hedge market at this time. So Patrick, are there other questions?

Mr. Quinn, do you have any more questions?